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Basel Committee on Banking Supervision (BCBS)
November 2017 Research and Development
Guidelines on identification and
management of step-in risk
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List of abbreviations
Abbreviations Meaning
BCBS Basel Committee on Banking
Supervision
CDO Collateralised Debt Obligation
CLO Collateralised Loan Obligation
CMBS Commercial Mortgage-Backed
Securities
LCR Liquidity Coverage Ratio
RMBS Residential Mortgage-Backed
Securities
SIV Structured Investment Vehicle
TOB Tender Option Bond
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Index
Introduction
Executive summary
Detail
Next steps
Annexes
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In October 2017, the BCBS published Guidelines on the identification and management
of step-in risk1, establishing a conceptual framework for identifying and managing
step-in risk potentially embedded in bank’s relationships with unconsolidated entities
Introduction
This Technical Note includes an analysis of the content of these Guidelines.
The recent global financial crisis showed that banks sometimes have incentives beyond contractual obligation to support
unconsolidated entities to which they are connected. In some cases, banks preferred to support certain shadow banking
entities in financial distress, rather than allow them to fail and face a loss of reputation, even though they had neither
ownership interests in such entities nor any contractual obligations to support them
• In this context, following the two consultation papers published in December 2015 and March 2017, the BCBS
published Guidelines on the identification and management of step-in risk.
• The BCBS aims to mitigate potential spillover effects from the shadow banking system through the application of
more generic lessons about risk related to banks’ connections with unconsolidated entities, and, as such, to identify
situations where step-in risk exists and needs to be anticipated.
• To this end, these Guidelines entail no automatic Pillar 1 capital or liquidity charge additional to the existing Basel
standards. Rather, they provide banks and supervisors with a method for identifying step-in risk and with a list of
possible responses that leverage existing prudential tools by informing or supplementing them.
(1) Step-in risk is defined as the risk that a bank decides to provide financial support to an
unconsolidated entity that is facing stress, in the absence of, or in excess of, any
contractual obligations to provide such support
Introduction
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Index
Introduction
Executive summary
Detail
Next steps
Annexes
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Regulatory context
Executive summary
This conceptual framework, which is intended to enter into force no later
than 2020, specifies the role of banks and supervisors for the
identification and management of step-in risk
• Among others, these publications by the BCBS1:
i) enhancements to the Basel II framework, ii)
revised securitisation framework; iii) LCR; and iv)
capital requirements for equity investment in funds.
Scope of application
• The Guidelines should enter
into force no later than 2020.
Next steps
Main content
Executive summary
• Banks subject to
the Basel
framework.
Role of banks
• Banks should regularly assess step-in risk taking the following steps:
1. Definition of entities to be evaluated for potential step-in risk (i.e. unconsolidated entities that maintain one of the 3 types of relationships specified by the BCBS).
2. Exclusion of entities immaterial or subject to collective rebuttals 3. Assessment of the remaining entities against indicators (e.g. nature and degree of the sponsorship, degree of
influence, implicit support, etc.). 4. Determination of the estimation method and appropriate actions (e.g. inclusion of an entity in the regulatory
scope of consolidation, conversion approach). 5. Reporting of the self-assessment, using the templates provided by the BCBS.
• In addition to the regular self-assessment, banks must establish policies and procedures that describe the processes used to identify entities that are unconsolidated and the associated step-in risks.
• Supervisors should review banks’ policies and procedures and their regular step-in risk self-assessments.
• Supervisors should have the authority to ask banks to remedy any deficiencies in their risk management approach.
Role of supervisors
(1) The step-in risk framework is intended to complement the existing provisions.
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Index
Introduction
Executive summary
Detail
Next steps
Annexes
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Detail
Overview of the framework Banks’ self-assessment of step-in risk should be conducted following a five-stage
procedure. In addition to this assessment, banks must establish policies in this regard.
Both the self-assessments and the step-in risk policies should be reviewed by supervisors
Overview of the framework
Definition of entities
to be evaluated
Banks‘ self-assessment of step-in risk, and policies and procedures
Supervisory response
1
Exclusion of entities immaterial or subject to
collective rebuttals 2
Assessment of the remaining entities against indicators
3
Determination of the estimation method and
appropriate actions 4
Reporting of the self-assessment
5
Define the scope of all entities to be evaluated for potential step-in risk,
taking into account their relationship with the bank (i.e. sponsorship, debt or
equity investor, or other contractual and non-contractual involvement).
Identify entities that are immaterial or subject to collective rebuttals and
exclude them from the initial set of entities to be evaluated.
Assess all remaining entities against the step-in risk indicators (e.g. nature and
degree of sponsorship, degree of influence, implicit support, liquidity stress, etc.)
including potential mitigants.
For entities where step-in risk is identified, use the estimation method deemed
appropriate to estimate the potential impact on liquidity and capital positions and
determine the appropriate internal risk management action.
Each bank reports its self-assessment of step-in risk to its supervisor.
After reviewing the bank’s self-assessment analysis, where necessary supported by an analysis of the bank’s policies
and procedures, the national supervisor should decide whether there is a need for additional supervisory response.
Banks must establish policies and procedures that describe the processes used to identify entities that are
unconsolidated and the associated step-in risks.
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The BCBS defines the entities that banks should consider for the purpose of step-in risk.
The initial set of entities under scrutiny contains any unconsolidated entity
whose relationship with the bank corresponds to the ones below
Definition of entities to be evaluated
Scope of
application
• The initial set of entities under scrutiny contains any unconsolidated entities. For the purposes of
this framework, an unconsolidated entity is defined as an entity not within the scope of regulatory
consolidation1.
• The BCBS does not specify a prescribed list of entity types that should be subject to the
identification and assessment. Nonetheless, as a minimum, banks are expected to scrutinise
securitisation vehicles, investment funds and other entities2.
(1) Under the Basel framework, the scope of regulatory consolidation includes all banking
and financial entities meeting regulatory criteria or threshold for triggering consolidation.
(2) For further information see Annex 1. This list provided by the BCBS is only for indicative
purposes and is not comprehensive.
Relationships
under
scrutiny
Specific
cases
• Insurance entities, that are currently specifically excluded from the regulatory scope of
consolidation are presumed not to be included within the scope of the framework (as they are
already subject to specific prudential treatment).
• Commercial entities (i.e. non-financial) may in general be excluded from the step-in risk
analysis. However, a commercial entity that provides critical operational service(s) to the bank
and cannot be substituted in a timely fashion or without excessive costs, should be considered
in the scope of the framework.
• A bank is not required to evaluate all entities with which it has a relationship, but those where the
bank has one or more of the following relationships with an entity:
• Sponsor: the bank manages or advises the entity, places its securities into the market, or
provides it with liquidity and/ or credit enhancements.
• Debt or equity investor: the bank invests in the entity’s debt or equity instruments. However,
banks should exclude regular business (e.g. lending relationship to operating entities and
investments that arise from market-making).
• Other contractual and non-contractual involvement: the bank is exposed to the risks or to equity-
like returns from the assets of the entity or related to its performance.
Detail
Banks’ self-assessment of step-in risk
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Banks should then exclude entities immaterial or subject to collective rebuttals,
because a law or a regulation explicitly prohibit banks from stepping in to
support those entities, from the initial set of entities to be evaluated
Exclusion of entities immaterial or subject to collective rebuttals
Entities
immaterial
• An entity may be excluded from the step-in risk analysis if, given its the size, stepping in to support
it would not significantly impact the bank’s liquidity and/or capital position1.
• This materiality policy should consider both the liquidity and capital requirements that would arise
from stepping in to support the entity as well as the broader adverse consequences of not stepping
in. In performing the materiality evaluation, similar entities should be evaluated in aggregate to
consider the ‘contagion’ risk.
• Entities considered as immaterial for step-in risk purposes should still be subject to an aggregate
reporting to the supervisor.
(1) A bank should establish its own internal policy for determining materiality, subject to
supervisory review.
(2) Contract law or industry standards are not be considered eligible for collective rebuttal.
Collective
rebuttals
• National jurisdictions may explicitly prohibit banks from stepping in to support certain entities. In
such cases, the banks are not required to analyse or report the step-in risk associated.
• Only a law or a regulation which is clearly enforceable, of general application and which explicitly
prohibits the provision of support, can be considered as a collective rebuttal2. Thus, its rebuttal effect
can only be recognised for those types of entity that are affected by these rules.
• The bank should specify in its policies and procedures the types of entity excluded due to a
collective rebuttal and keep a list of such entities available on supervisory request.
Detail
Banks’ self-assessment of step-in risk
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Banks should assess all remaining entities against certain step-in risk indicators1.
These indicators, which might be adapted for inclusion in the bank’s policies and
procedures for managing step-in risk, refer to nature of the sponsorship…
Assessment of the remaining entities against indicators (1/2)
Nature and
degree of the
sponsorship
• The bank may be exposed to a greater degree of step-in risk, such as when it provides:
• Full sponsor support (via a guarantee or other credit enhancement).
• Partial credit enhancements and liquidity facilities while playing a role in decision-making.
Degree of
influence
• This indicator is not meant to be synonymous with the accounting notion of power/control that is a
prerequisite for accounting consolidation, but rather a lower threshold (e.g. significant influence).
Examples: Capital ties < 50% and power to exercise a significant influence over the management.
Capital ties > 50% but no regulatory consolidation.
No capital ties but ability to remove and appoint board of directors.
Implicit
support
Leveraged
entities
Liquidity
stress
• This indicator takes into account whether the bank is providing an implicit guarantee (e.g. the
investor is accepting a lower rate of return on its investment relative to risk, potentially indicating that
the investor expects the sponsoring bank to support the entity in a stress scenario).
• This indicator should also take into account the entity´s credit rating, whether assigned by a third-
party rating agency or internally by the bank, and specifically the extent to which the entity’s rating is
dependent on the bank’s credit rating.
• Highly leverage entities are more prone to step-in risk than adequately capitalised entities.
Examples: Structured vehicles under IFRS and variable interest entities under US GAAP.
• This indicator refers to entities with a limited capacity to access liquidity (e.g. long-term assets are
funded with short-term liabilities) when facing an unanticipated increase in redemption requests and
which would impact the bank’s liquidity should it conclude that it must provide step-in support.
(1) The indicators provided by the BCBS should not be considered exhaustive. Generally,
all these indicators need to be considered, although in certain cases one indicator
alone may be sufficient to trigger the identification of step-in risk.
Detail
Banks’ self-assessment of step-in risk
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Risk
transparency
• It refers to an entity’s degree of transparency, and the extent to which investors are provided with
detailed information that allows them to understand and assess its risk-adjusted returns.
Examples: Entities where the risk in underlying investments is opaque, or that cannot be rated.
Investor risk
alignment
• This indicator refers to entities whose activities do not sufficiently match the risk profiles of their
clients/investors with those of the risk exposures of the entity.
Reputational
risk
• This indicator refers to the potential harm to a bank’s reputation when an entity has clients in
common with the bank and also carries the bank’s brand (e.g. corporate name, logo)1.
• The evaluation should also consider the degree to which cross-selling is part of the bank’s overall
strategy, as it increases reputational risk and incentives to provide step-in support.
Historical
dependence
Regulatory
restrictions
and mitigants
• This indicator refers to banking, securities, market and other financial regulations that restrict,
without prohibiting, a bank’s ability and/or propensity to support an entity on terms that are
unfavourable to the bank.
Examples: Entities for which higher capital requirements are set to cover potential step-in situations.
…degree of influence, implicit support, leverage, liquidity stress, risk transparency,
accounting disclosures, investor risk alignment, reputational risk,
historical dependence, and regulatory restrictions
Accounting
disclosures
• Accounting disclosure requirements can provide meaningful information to evaluate the nature
and risks of a bank’s involvement with unconsolidated entities.
Examples: Exposures towards unconsolidated entities disclosed under IFRS 12.
(1) Branding could strengthen the presumption of step-in support, especially if the brand is
associated with a deposit-taking institution in the same banking group.
• This indicator refers to documented instances where step-in support has been provided
previously to specific types of entity.
Examples: Step-in risk support was provided to money market mutual funds during the crisis.
Assessment of the remaining entities against indicators (2/2)
Detail
Banks’ self-assessment of step-in risk
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For entities where step-in risk is identified, banks should determine the appropriate risk
management action. Responses may be comprehensive, such as the inclusion of
entities in the regulatory scope of consolidation or the conversion approach…
Determination of the estimation method and appropriate actions (1/2)
Potential
responses to
step-in risk
• The Basel II framework already requires banks to measure the amount of support they might have
to provide or the losses they might experience.
• A bank’s approach to step-in risk management and measurement should be sensitive to residual
risk (i.e. after taking into account of possible risk mitigants).
• When a bank identifies significant step-in risk to an entity, it can apply a range of potential risk
measurement and management measures. Some of these measures have a more encompassing
effect on banks than do others, while other measures might have a more targeted impact.
Regulatory
scope of
consolidation
Detail
Banks’ self-assessment of step-in risk
Conversion
approach
(1) In particular where the entity’s balance sheet structure and activities are amenable to
banking regulations. Nonetheless, this measure might not be appropriate when
consolidation would artificially improve capital or liquidity position of the bank.
• When the step-in risk identification and assessment process concludes that significant step-in
risk exists in relationships with certain unconsolidated entities, but that consolidation would not
be appropriate, using a conversion factor to estimate the risk might be appropriate.
• This conversion factor would be applied to the entity’s exposures (in accordance with the
specifications provided by the BCBS) and will be used to determine a response in terms of
increased capital and/or liquidity requirements. It would be specific, since a uniform ‘one
size fits all’ conversion factor may not be sufficiently risk-sensitive.
• Where a bank already has substantial contractual obligations to provide support to another
entity at a time of stress, inclusion of the entity in the regulatory scope of consolidation may be
the most appropriate measure1.
• Certain situations would generate a strong presumption that consolidation ought to be applied.
(e.g. the entity appears to have been designed to avoid regulatory consolidation).
• This measure does not require any further quantification of the step-in risk because the risk
is essentially addressed through the entity’s consolidation.
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Stress
testing
Provisioning
Punitive
ex post capital
charges
Large exposure-
like internal limit
Disclosure
• The existing provisions in the liquidity standards could be used to account for step-in risk.
• In particular, the LCR addresses the potential need for the bank to buy back debt non-
contractual obligations in order to mitigate reputational risk; and the NSFR requires stable
funding factors for off-balance sheet exposures, including for non-contractual obligations.
• Banks and supervisors may decide to include in their stress-testing framework entities that
are not part of the regulatory scope of consolidation of the banking group.
• The results of such stress testing would be expected to help a bank consider whether it
needs additional capital or liquidity in respect of these unconsolidated entities.
• Banks and supervisors might build upon the accounting framework for provisioning. For
instance, this might take the form of estimating the potential cash outflows resulting from a step-
in, assessing them against the expected fire sale value of the entity’s assets1.
• When a bank actually steps in to support an entity beyond its contractual obligations,
supervisors might require either the post-step-in exposure be risk-weighted at a considerably
higher level than under the default rules, or that the entity’s total assets be brought onto the
bank’s balance sheet at the prevailing risk weight.
• This specific measure requires a bank to apply an internal limit to all of its contractual
exposures and/or estimation of step-in risk to shadow banking entities.
• To mitigate step-in risk through market discipline, banks and supervisors might require public
disclosures, such as the number, size and nature of unconsolidated entities, and of banks’
own risk assessment and their management of such exposures2.
(1) This method could be compared with the conversion approach but its practical
implementation requires a deduction from CET1 rather than an increase in capital.
(2) As a potential downside, market participants could interpret them as implying that a
requirement exists to step in, even where there is no contractual commitment to do so.
…or targeted measures, such as the use of the liquidity standards, the inclusion of the
entities in the stress testing framework, the use of an ex post capital charge, etc.
Determination of the estimation method and appropriate actions (2/2)
Detail
Banks’ self-assessment of step-in risk
Liquidity
requirements
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Reporting of the self-assessment
Finally, banks should report their self-assessments of step-in risk to its supervisor,
using the reporting templates provided by the BCBS to this end
Reporting
to the
supervisor1
• Banks must regularly report the results of their self-assessment of step-in risk to their supervisor.
The expectation is that this reporting becomes mandatory and should be submitted annually. The
information contained in two templates is organised as follows1:
• Template 1 details the number and types of entity that were initially identified for review
purposes (except those subject to collective rebuttals). These entities should be grouped under
three categories: i) immaterial; ii) material but for which step-in risk is insignificant; and iii)
material and for which step-in risk is significant.
• Template 2 details, for entities deemed material and with significant step-in risk, the nature of
the step-in risk, and the action taken by the bank to limit, mitigate or recognise this risk.
(1) The reporting templates as specified by the BCBS are included in Annex 2.
Detail
Banks’ self-assessment of step-in risk
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In addition to the regular self-assessment, banks must establish and maintain policies
and procedures that describe the processes used to identify entities
that are unconsolidated and the associated step-in risks
Policies and procedures
Banks’
policies and
procedures
• Banks must establish and maintain policies and procedures that describe the processes used to
identify entities that are unconsolidated and the associated step-in risks, which should:
• Clearly describe the identification criteria that banks use to identify the step-in, which should
include, at a minimum, those specified before (step 3).
• Not be prescriptive or geared towards any particular type of entity.
• Clearly describe the specific provisions of the laws or regulations acting as collective rebuttals
and list the types of entities covered by those laws or regulations.
• Describe the internal parties responsible for identifying, monitoring, assessing, mitigating and
managing the potential step-in risk.
• Clearly describe the bank’s own definition and criteria of ‘materiality’, and their rationale.
• Document the process to obtain the necessary information to conduct the self-assessment.
• Be reviewed regularly, and whenever there is any material change in the types of entity or in
the risk profile of entities1.
• Require the self-assessment to be included in the internal risk management processes,
subject to independent controls, and to be discussed by the appropriate risk committee.
• Be documented and available for supervisory review upon request.
(1) If there have been no material changes, they should be reviewed in accordance with
the bank’s own policy on frequency of review of policy documents, or at least every
three years.
Detail
Banks’ self-assessment of step-in risk
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Supervisors should review banks’ policies and procedures and their regular step-in risk
self-assessments, and should have the authority to ask banks to remedy
any deficiencies in their risk management approach
Supervisory response
Review of
policies and
procedures
• At a frequency to be determined, supervisors may request a bank’s step-in risk identification and
assessment policies and procedures and assess banks on, among others, the following topics1:
• Adequacy and quality of policies and processes with regard to the identification, assessment,
management and control of step-in risk.
• Adequacy on the internal policy to determine materiality and criteria used to this end.
• Adequacy of risk management and measurement system.
• Integrity of management information systems.
• Conceptual soundness of internal capital and liquidity assessment and adequacy processes.
• Soundness of internal controls and internal audit, and any findings of internal controls and
internal audit with regard to step-in risk assessment.
• Previous provision of step-in support to entities.
• Supervisors are expected to:
• Ensure that banks have conducted appropriate self-assessments of the eligible collective
rebuttal presumptions, including the appropriate interpretation and application of relevant laws.
• Review the materiality criteria to ensure that they are reasonable.
Review of the
self-assessments
• Regardless of the frequency, granularity or format of the reporting requirements, banks should
regularly assess step-in risk. Supervisors will consider each particular case and its specific features.
• In case the assessment reveals that significant residual step-in risks have not been
appropriately estimated or mitigated, supervisors may use the measures that they determine
appropriate in the circumstances, based on the nature and extent of step-in risks2. The types
of response that supervisors may consider were outlined before (step 4).
• Reporting is to be used by supervisors to assess the adequacy of the banks’ self-assessment
and the magnitude of residual step-in risk identified.
• Supervisors should have the authority to ask banks to remedy any deficiencies in their risk
management approach.
Detail
Supervisory response
(1) In reviewing a bank’s policies or procedures, supervisors may make use of its internal findings, including
those from the bank’s internal control or audit areas.
(2) Considering the probability and magnitude of step-in risk.
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Index
Introduction
Executive summary
Detail
Next steps
Annexes
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Next steps
Calendar
Next steps
• The step-in risk framework should enter into force as soon as possible and no
later than 2020.
The step-in risk framework should enter into force as soon as possible and
no later than 2020. The BCBS intends to monitor jurisdictions’
progress in implementing these guidelines
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Introduction
Executive summary
Detail
Next steps
Annexes
Index
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Annex 1
Entity categories
Banks are expected to assess entities listed below. Nonetheless,
this list is provided for indicative purposes and is not comprehensive
Categories
of entities
• The entity categories specified by the BCBS are the following:
• Entities issuing residential mortgage-backed securities (RMBS) and commercial mortgage-
backed securities (CMBS) or other assets (e.g. credit cards).
• Entities issuing covered bonds.
• Entities issuing collateralised debt obligations (CDOs) and collateralised loan obligations
(CLOs), including cash and synthetic CDOs.
• Entities issuing tender option bonds (TOBs).
• Entities issuing asset-backed commercial paper (ACBP).
• Securities arbitrage conduits.
• Structured investment vehicles (SIVs).
• Repackaging vehicles.
• Real estate investment trusts.
• Mutual funds, including money market funds (and equivalent mutual funds in other jurisdictions),
and exchange-traded funds.
• Hedge funds.
• Private equity funds.
• Finance companies.
• Securities firms.
Entity categories
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Annex 2
Reporting templates
In template 1, banks should detail the number and types of entities
that were initially identified for review purposes
Template 1
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Annex 2
Reporting templates
In template 2, banks should detail for each material entity (or group of similar entities) for
which step-in risk is estimated as significant the nature of the step-in risk…
Template 2 (1/2)
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Annex 2
Reporting templates
…as well as the action taken by the bank to limit, mitigate or recognise this risk
Template 2 (2/2)